Financial Stability Effect of Yield-Oriented Investment Behaviour

Abstract

We examine the effect of low interest rates on bond portfolio and market allocations by all institutional investors and households across all bond types in Germany at the security-level for 2005-2016. We find that―in contrast to banks―non-banks tilt bond portfolios significantly towards riskier assets when interest rates are low. Importantly, we show that these portfolio allocations are associated with increased individual downside risk and substantial shifts in market-wide bond allocations. We use the 2015-Bund tantrum as a quasi-natural experiment to assess implications of these market-wide shifts for financial market outcomes in response to sharp yield reversals.

Keywords: Portfolio allocation, fixed income, yield reversals, financial stress, financial stability

JEL Classification: G11, G23, E43